Transcript Demand Based Pricing: A Company Perspective CAS Spring Meeting May 18, 2004 Floyd M.

Demand Based Pricing:
A Company Perspective
CAS Spring Meeting
May 18, 2004
Floyd M. Yager, FCAS, MAAA
Allstate Insurance Company
May 18, 2004
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Disclaimer

The views expressed in this presentation are
consistent with, but do not necessarily
represent the position of, Allstate Insurance
Company. The views expressed herein are
subject to the understanding that all
applicable state and federal law must be
adhered to at all times.
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Issues to Cover
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Historically, actuaries have focused more on the supply curve
than the demand curve
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Focus on rates and ratemaking regulation
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Maintaining actuarial objectivity while helping our company
optimize results
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Working with Product Managers and using indicated rates in
marketing decisions around price
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Difficulty in modeling elasticity and using the results
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Background
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Pricing based on demand is not a new concept in many
industries.
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With many products this is the way prices are set:
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Airlines
Hotel Rooms
Package Goods
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Many products priced so that supply and demand align
Adjust prices to “move” inventory
Charge people what they are willing to pay
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Historical Study
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Ratemaking Practice has focused on understanding
costs
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Modeling loss costs for overall rates and for segments
in classification ratemaking is a primary function of
actuaries
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Statement of Principles Regarding Property and
Casualty Ratemaking says, in the Definition section:
“…This statement is limited to principles applicable to the estimation
of these costs. Such costs include claims, claim settlement
expenses, operational and administrative expenses, and the cost of
capital…”
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Historical Study
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For overall rates, Loss Ratio and Pure Premium Methods focus
on estimation of loss costs in future period
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Profit provisions have tended to be an academic exercise and
regulated like utilities rather than be determined in the competitive
market
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General classification ratemaking concentrates on differences in
loss relativities among classes
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Neither method gives consideration to changes in the overall
volume or mix of business as a result of any change to the rates
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Historical Study
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There has been some recognition of the role of elasticity in
ratemaking, here are two examples:
“Ratemaking for Maximum Profitability,” Lee M. Bowron, and Donald
E. Manis, CAS Forum Winter 2001
Includes ideas for selecting an overall rate change given elasticity of a book
and the overall objective of the company.
“Personal Automobile Premiums: An Asset Share Pricing Approach for
Property-Casualty Insurance,” Sholom Feldblum, PCAS LXXXIII,
1996
Persistency as a factor in pricing for a return over time.
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Neither paper discusses how to get good elasticity measures.
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Focus on Rates
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Due to the focus on understanding of loss costs and expenses
actuaries have been counted on for the production of rates
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Focus has been to meet regulatory requirements and actuarial
standards
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Rates should be reasonable and not excessive, inadequate, or
unfairly discriminatory
If rates are an actuarially sound estimate of the expected value of
future costs associated with an individual risk transfer they can
meet this standard
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Maintaining Objectivity
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In many companies, actuaries have provided the “voice of
reason”
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Role has been to keep the rates appropriate when sales and
others pushed for growth at “all costs”
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Bottom line responsibility: it has been paramount for actuaries
to avoid insolvencies
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Now we are being asked to maintain appropriate rates while
working with Product Managers to grow the business
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Product Management
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Product managers are charged with the growth and profit for a
market (line of business, state, or combination)
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Many live the 4 P’s of Marketing (Product, Price, Place,
Promotion)
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Actuaries can clearly help understand what the range of the
“right” price for the product may be
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The actuarial rate, as developed by analysis of the costs, needs
to be reconciled with the economic price (what a consumer is
willing to pay in a competitive market)
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Product Management
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Actuaries are positioned to help our companies by bringing
analytical skills to more problems
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Unique understanding of insurance data, regulatory
environments, and modeling techniques
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Actuaries can bring perspective around the 3 C’s of Marketing
(Cost, Customer, Competition)
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How do we use our skills to work with Product Managers to
provide input to final pricing decisions?
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Product Management
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In the Conclusion of Statement of Principles Regarding Property
and Casualty Ratemaking we find:
“Other business considerations are also a part of ratemaking. By interacting
with professionals from various fields including underwriting, marketing,
law, claims, and finance, the actuary has a key role in the ratemaking
process.”
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We need to find ways to bring our analytical skills to the
problems our companies may face, growing market share while
maintaining appropriate returns over time
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One way may be improving our understanding of demand for
the insurance product and communicating how changes to rates
may affect the company’s ability to attract and retain business
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Elasticity
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Price elasticity probably varies significantly by state and line of
business
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Worker’s Comp in a state with mandated rates likely to be more
inelastic than the market for Catastrophe Reinsurance
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Segments of business likely have differences in elasticity
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Within a book of business you can see the effect of varying renewal
elasticities in the fact that different segments show different
retention after a rate change
New versus renewal
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Elasticity
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Modeling elasticity is not easy
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Data to understand how past actions have affected new and
renewal business may not be readily available
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Difficult to keep up to date on competitor changes
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Difficult to isolate even the rate decisions within your own
company
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Administrative changes happen at the same time
Changes in advertising and awareness of company
Other
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Elasticity
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Need to balance the indicated and supportable rate through
proven actuarial techniques with decision on price
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Price which “optimizes” your company objectives probably does
not equal your indicated rate
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An “optimal” rate is above the indication is not necessarily
excessive.
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An “optimal” rate is below the indication is not necessarily
inadequate.
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Elasticity
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Elasticity and its use in the pricing process seems to be an area
ripe for study by actuaries
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An understanding of the behavior of consumers as we adjust
rates and work on behalf of our companies is necessary to help
guide better business decisions
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